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Kenya: oil and gas update

Kenya has become a place of active and serious interest to oil and gas companies large and small. The numerous gas discoveries in Kenya are well documented. Expectations have reached new levels since spring 2012, when Tullow found oil in the Ngamia-1 well on Block 10BB, and encountered more oil a few months later.

Competitive licensing round

The Kenyan Ministry of Energy last month announced that it will offer up to nine oil and gas exploration licences in the first quarter of 2013, to be offered through competitive bidding. Crucially, the government has announced that it intends to auction these blocks (and future blocks) by way of public competitive tender to identify the highest bidder, rather than on a first come, first served basis, as was previously the case. Chevron and Eni are just two of what will no doubt be many major players that have publically expressed their immediate interest in joining existing licensees in Kenya. It is understood that the government recently hosted briefings on the proposed auction process.

Petroleum contracts

The Ministry of Energy and National Oil Corporation of Kenya are conducting the bidding round currently in process. They have stated that the terms and conditions of petroleum exploration contracts to be awarded to successful bidders are subject to negotiation, but will be governed by:

The Income Tax (Amendment) Act made to specify the fiscal regime applicable to petroleum operations.

The Ministry of Energy and National Oil Corporation of Kenya have published the basic terms of the exploration contracts to be entered into, and a model production sharing contract. The basic terms proposed by the government are listed below.

General terms

An initial exploration period, with two additional exploration periods to be negotiated with the government (and to be extended in the event of a discovery).

The duration of development and production periods in the event of a commercial discovery is to be negotiated.

The insertion of acreage surrender provisions is negotiable.

Surface and other fees are to be negotiated.

In relation to natural gas, the government states that it will consider special provisions on natural gas submitted by prospective contractors in their offers.

Fiscal terms

Both income tax and corporation tax are payable on behalf of the contractor on the proceeds raised from the sale of crude oil and gas sales. Corporation tax is listed as 37.5% for non-resident companies and 30% for resident companies. Taxes are stated to be payable (on behalf of the contractor) by the government from its profit oil share.

Government participation

The government states that it may elect to participate in any development area, however the percentage of participating interest is negotiable between the parties.

Regulatory and legislative changes

Notwithstanding the current licensing round, formal regulatory and legislative changes are afoot in Kenya. Whilst the current bidding round is being conducted in line with existing regulatory provisions as described above, the Ministry of Energy is proposing a new Petroleum Exploration and Production Act (PEPA). Whilst this bill is only at the drafting stage, the government has confirmed that some of the concepts contained will include: sharply increased licensing fees; higher royalties, increased taxes; and tougher penalties on missed exploration schedules. It will be interesting to see the course that negotiations in the current licensing round take i.e. whether the government will adopt a robust approach in line with its proposed new legislation.

The full details of what else may follow in the draft PEPA text are yet to be announced; however Patrick Nyoike, the Energy Permanent Secretary, was recently quoted as stating: “bank guarantees, annual training fees for civil servants involved in petroleum activities and terms for new PSCs will be reviewed upwards as Kenya is no longer a frontier exploration area”. Kenya’s Ministry of Energy is also currently developing draft natural gas terms.

As a further indication of what may be forthcoming in PEPA, in May 2012 the Ministry of Energy published its third, non-binding, draft Energy Policy, which set a strategic frame-work for proposed energy sector developments and facilitation of energy infrastructure. The Energy Policy proposes a review of the existing Petroleum (Exploration and Production) Act (Cap. 308) and to formulate guidelines in the proposed new legislation (which we presume refers to PEPA) to provide for:

Terms of assignment, change of control and transfer of PSCs; and charge of royalties on revenues earned as a result of the assignment or transfer of PSCs to third parties by licensees.

The development a policy on management of commercial discoveries of petroleum resources.

The government’s stated aim is to enact PEPA by autumn of this year.

Cove tax dispute

What is clear is that resource nationalism sentiment in Kenya, as in many other African states, is growing. The government is keen to increase the revenue the country will receive from its oil and gas natural resources. Kenya is not only considering its future regulatory regime but also scrutinising current transactions through the interpretive lens of existing legislation and tax regimes. Kenya has for example recently declined to approve the transfer of the oil and gas exploration interests of Cove Energy Plc to Thailand’s PTT Exploration and Production Public Company Ltd (PTTEP), over a tax dispute. The Ministry of Energy has said the approval will only be granted after Cove pays Kenya tax on sale proceeds realised.

Elections

This year, Kenya will hold its first general election since the disputed and controversial elections held in 2007 and the re-election of President Mwai Kibaki. According to reports, a period of unrest ensued in which 700,000 were displaced throughout the country. The election campaign of this year is already proving acrimonious, although thankfully so far peaceful, as one of the leading presidential candidates, Uhuru Kenyatta, and his running mate William Ruto, face trial at the International Criminal Court on charges that they helped to organise the post-election violence five years ago.

Whilst it is expected that any new or re-elected government will seek to introduce legislative reform to the petroleum industry, experience in certain other African states suggests that such legislation can remain in the drafting for many years. Whilst many interested parties will hope that is not the case, it is a fact that political risk and instability remain key factors in considering operations in Kenya. Political stability is not only key for Kenya’s prospects, but will also be important for its landlocked neighbours including Uganda, Rwanda and South Sudan, for whom access to port facilities at Mombasa is also crucial.

Predicting election results is a perilous activity at the best of times, and in Kenya it is extremely difficult. Analysts predict that a free and fair election would be close to call. From a petroleum industry perspective, one might assume that a re-elected president Mwai Kibaki would seek to bring PEPA into force.

Conclusion

The current government is clear in its intention to enact the PEPA. In the meantime, it proposes to conduct the current licensing round on the basis of some of the principles it proposes PEPA will contain.

Kenya, like several of its East African neighbours, has a real and exciting opportunity to build thriving oil, gas and LNG industries together with downstream power generation projects. However, there remain significant challenges. The government would do well to avoid the difficulties faced by certain other African states by enacting PEPA, in an internationally competitive and transparent form,to ensure that Kenya is a desirable location for inward investment. Furthermore, Kenya should continue to encourage development of the various and large amount of de-bottle-necking infrastructure that will be required.